Goldman Sachs warns on Fed communication strategy risks

Investing.com -- Goldman Sachs has raised concerns about Federal Reserve Chairman Kevin Warsh's approach to central bank communication. Warsh has advocated for providing less information about the Fed's reaction function to encourage financial market participants to assess the economy independently rather than through the filter of likely Federal Open Market Committee responses.

Warsh wants markets to "learn to play the ball, not the referee" and believes this approach will allow the FOMC to receive more "direct and unfiltered" information about the economy from markets.

Goldman Sachs identified a flaw in this strategy. The bank noted that participants in short-term interest rate markets, where Fed communication has the most impact, price what they expect the Fed will do rather than what it should do. This dynamic persists even if the FOMC reduces information about its reaction function, Goldman said.

The investment bank warned that reduced communication would make markets more prone to errors. Goldman stated this shift would not provide policymakers with more reliable information. The bank added that such a change could extend the lags of monetary policy and introduce unnecessary volatility into financial conditions and the real economy.

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